Sigrún Davíðsdóttir's Icelog

Friday 6 March Central Bank of Iceland changed rules for offshore króna investment in order to prepare for lifting capital controls. Restricting the investment possibilities might seem only to increase the króna pressure, not lessen it but this step is a first step or half a step: further measure for binding these funds or attracting them with good offers will follow. This is a step in the right direction – but only if other measures follow. And so far, there is nothing to indicate that there is any rapprochement in diverging views on how to solve the ISK problems of the estates of the old banks. The problem is that the government seems to be looking for a solution that does not exist – and this is very time-consuming as the Scot looking for a penny where he had not lost it found out

Foreign-owned króna, or offshore króna, was the original problem, which on November 28 2008 called for capital controls. At the time, this overhang amounted to 44% of GDP but has since dwindled down to 15%. The rules regarding investment of offshore ISK have now been changed.

The new amendments to the CBI exemption lists and to the Rules on Foreign Exchange and the Foreign Exchange Act mean that there are now only two option for the offshore ISK to invest in: Treasury bills and one Treasury Bond, RIKB 15 0408. As before, interests earned can still be taken out of the country.

Restrictions might seem counter-productive – but this move is the first one: other investment offers will follow. To Reuters CBI governor Már Guðmundsson said the aim is to reduce the overhang and to induce investors to stay in Iceland when further steps towards liberalisation will be taken. “… it would be very imprudent if we were just to assume that these 15 percent were stable… We will shortly be offering investors alternatives … and these alternatives are such that they will greatly reduce the likelihood of instability when controls are lifted.” Guðmundsson said that further measured will be announced in a “few weeks or very few months.” Minister of finance Bjarni Benediktsson said to Rúv that the work is aimed to finish within the first half of this year.

There have lately been changes in the government’s advisers: now Eiríkur Svavarsson has left. The rumour is that Glenn Kim has not been seen much in Iceland lately. And as before: no official announcement of any changes, neither of Svavarsson leaving or the new member, Ásgeir Helgi Reykfjörð Gylfason, who recently joined the government’s group of advisers.

The focus of these measures is only offshore ISK. Still unsolved are the foreign-owned ISK assets in the estate of the failed bank, admittedly the politically most difficult nut to crack. It seems that instead of using tried and tested measures from other countries with capital controls the government is trying to find a solution that does not exist. Meanwhile, Iceland is trapped in capital controls.

CBI’s new measures – in detail

Those holding RIKB 16 etc are not being forced to give up their holding – but for reinvestment there is nothing on offer except about-to-expire maturity and Treasury bills. The crude choice for the offshore ISK owners is either to use deposits accounts to keep their funds or accept the new double offer of Treasury bills or RIKB 15 0408, which is maturing 8 April. Amongst those who follow things in Iceland the feeling is that the imminent maturity was a significant reason for acting now considering the fact that maturity of a big issuance is in sight.

At the end of January foreign-owned RIKB 15 amounted to ISK18.7bn (might have changed in February since RIKB 15 could be swapped for RIKB 17; now no longer possible). The RIKB 16, maturing 13 October 2016 is a much larger issuance where foreigners owned ISK57.9bn.

The effect of the changes is that offshore ISK holders cannot swap to longer maturity. Longer maturity gives less impetus to leave, creating possible hold-outs and unforeseen behaviour, from the point of view of the CBI. Consequently, whatever the possible offer will be the hold-out problem is less, or so the thought goes. When this future offer comes, whatever it will be, the offshore ISK holders are more likely to participate.

The critical issuance might be the RIKB 19, where the foreign holding is ISK42.9bn – those holding longer maturity are unlikely to make a move since hopefully/most likely the controls will have been lifted by then. Those with shorter maturity might give it a thought to swap into what is now on offer. Those with RIKB 19 are in the tricky situation of having to gauge the likely scenario.

After the RIKB 15 0408 matures now in April offshore ISK holders can only reinvest in Treasury bills. Interestingly, some years ago foreigners were the largest holders of T-bills but there is at present no foreign-owned holding there. This is bound to change. Treasury bills now amount to ISK22.1bn but is expected to rise to ISK30bn at the end of the year. Next Treasury bills’ issuance in on 18 March.

In an interview on Rúv minister of finance Bjarni Benediktsson said that the government was now well on its way to solve the offshore ISK problem and this could be seen as the first steps towards lifting the controls. “These are preparatory actions, which in a short while could result in the offshore ISK problem being behind us.”

Further, Benediktsson said that the investment options was being restricted but nothing was taken away from anyone. The idea is, according to Benediktsson, to eradicate uncertainty and prepare the ground for further action.

Next step: what and when?

There is of course no official answer to the questions above. However, since the guiding idea is to bind funds to hinder instability the offer clearly has to be long maturity bonds – there have long been rumours that the euro bonds might be offered. Remains to be seen.

Apart from what will be offered the question is when. Governor Guðmundsson vaguely talks about few weeks or few months. To Rúv minister of finance Bjarni Benediktsson said the new investment offers were being worked on. “We hope to conclude this part of the matter in the coming months. I would mention the first half of the year in this context. That is what all our work aims at but it would not be responsible to fix exact dates.”

Considering how tortuous the path towards lifting the controls has been so far, in spite of the optimism expressed by Benediktsson and prime minister Sigmundur Davíð Gunnlaugsson when they came to power, it is not advisable to hold one’s breath. However, if the government wants to maintain credibility and trust in these issues, home and abroad, it has to act resolutely and not too sluggishly.

In terms of securing the offshore ISK funds, hindering instability, the measures now are only half a step: these are the restrictions – the offer to go with it, the other half step, is still missing. Until that step has been taken the usefulness of this measure cannot be judged.

Steps so far

Interestingly, Benediktsson talked about the new measures as the “first steps” towards lifting the capital controls. It can be debated which measures have been towards lifting controls but there have definitely been other measures, which merit to be called “steps towards lifting the controls.”

The first plan to lift controls was published in the summer of 2009 in co-operation with the International Monetary Fund as Iceland was then in an IMF programme. The CBI published a new plan in March 2011. The CBI auctions, an important step intended to reduce the offshore IKS, ended now in February.

Another major step was the bonds agreement between Landsbankinn and the LBI, the estate of the old Landsbanki May 5 2014. Although the agreement had been long time in the making Benediktsson, who needed to grant the exemption from capital controls in order to complete the agreement, took until December 4 2014 to grant the exemptions needed. I have earlier pointed out that it seems to have been more the irritation of the UK government, notably (fearsome) Andrea Leadsom, which pushed Benediktsson to take that step rather than any political energy and initiative on the Icelandic side.

The political outlook

There have been certain discernible trends lately in the political debate on the capital controls. Prime minister Gunnlaugsson has lately neither talked about the exact sums, the ISK billions, he claims the state should gain from the estates nor has he talked about vulture funds, as he did earlier. His new reasoning is “fairness:” Iceland suffered from the collapse of the banks, i.e. the banks caused sufferings and now it would be only fair that the banks paid back to the state for the hardship caused.

Apart from this rather narrow retelling of the collapse saga – after all the SIC report gave a somewhat more nuanced picture of a wider failure of public institutions, politicians and banks – Gunnlaugsson has referred to practices abroad, that foreign banks have paid fines to make up for their misdeeds towards society. (In general, the prime minister has become well known in Iceland for his at time rather inaccurate grasp of facts and reality).

Gunnlaugsson has also recently said in an article in Fréttablaðið that the new banks are too big, they got too much assets on too favourable terms, again arguments for the state getting a cut of the estates (an echo of an earlier debate where an old industrialist, Víglundur Þorsteinsson has been making similar claims, see here). On the same day Gunnlaugsson’s article was published, four members of In Defence, the organisation formed to fight the Icesave agreement, wrote an article in Kjarninn.

The four asked if the state is really going to enable foreign investors to run off with the equivalent of a whole year GDP, partly the profit from resurrecting the economy, paid for with the great sacrifice of Icelanders and sky-high loans. Their suggestion is an exit tax of 60%, not the 40% they claim Benediktsson has mentioned (which he has not; on the contrary he has been unwilling to confirm exit tax and much less any percentage). Gunnlaugsson was at the time very close to In Defense, which has neither been seen nor heard for years until now. It is hardly a coincidence that the two articles appeared the same day.

Benediktsson has mentioned the cost to society of the banking collapse but he has never argued for great sums to be gained from the resolution of the estates. In a speech last October he made some general comments on the controls, the topic of an earlier Icelog: Benediktsson want to avoid risk of legal wrangling with creditors and prefers simple and straightforward solutions.

Eiríkur Svavarsson, who now has left the group of the government advisers, was a vocal part of the In Defence group and is said to be close to the prime minister. Svavarsson has not been replaced. There has been no official announcements of this change, nor has there been a formal announcement of the new member, Ásgeir Helgi Reykfjörð Gylfason.

The prime minister has recently expressed his opinion that not too much should be said about the lifting of the controls since that might feed valuable intelligence to creditors. Whether the names of advisers are part of this intelligence, which should be hidden from creditors, is not clear. It does however look strangely lackadaisical that there is so little stringency as to what is announced and what is not.

Lately, members of Parliament have complained about the secrecy regarding lifting the controls, claiming they are kept uninformed. The Ministry of Finance has now published the text of the contract all advisers have to sign, see the text here (in English) with relevant laws on insiders. Interestingly, there is now gardening leave stipulated at the end of the assignment.

Glenn Kim is still in charge of the group, at least in name; some observers close to the process claim he is increasingly distant and not much seen in Iceland lately.

Looking for a solution that cannot be found

In earlier Icelogs I have often referred to an alleged split between the two government leaders as to how to tackle the estates. The two have time and again denied these rumours but the rumours are still alive and kicking. There are also speculations in the Icelandic media that the underlying strive of the government is to be in the position of deciding to whom the banks are sold.

Both government leaders have talked about the need for a holistic solution. Exit tax on all cross border transactions has i.a. been mentioned. The problem here is that this tax would hit all cross border capital, also debt payment of Icelandic entities – and it will not reduce the core problem: the foreign-owned ISK assets in the estates. I have the feeling that this idea has been abandoned: it might in theory bring the much-desired funds to the state (which is actually doing rather well, thank you, and not much wanting, compared to many other European countries) but it is for many reasons unworkable.

As I pointed out to Reuters it seems that these conflicting views prevent the government from acting on capital controls. But it might me more than only conflicting views. After watching one group of advisers after the other working on capital controls I cannot avoid the feeling that the government is looking for a solution that does not exist. A solution that i.a. would bring funds to the state, make it possible for the government to decide who owns the banks and yet be simple and risk-free. Like the drunken Scot looking for his penny under the street lamp because the light is there, though he lost it elsewhere, the government has been using, or squandering time, on a solution nowhere to be found.

This is doubly regrettable because the problems Iceland faces are neither unique nor particularly hard to solve. That is if, instead of looking for a home-grown Icelandic solution, advisers would look for realistic solutions where the gain would be not billions to the state but the trophy of lifting the controls. Instead, while the search for the non-existing solution, Icelandic businesses are slowly being starved of oxygen as always happens in countries with long-time capital controls.

As far as I understand the two government leaders have not reached an understanding as to how to proceed. Their statements on the capital controls and the banks normally point in different directions. The closer to dealing with the estates the more difficult to iron out these divergences and the harder the political cohesion of the government will be tested. As the drunken Scot found out looking for a solution where it demonstrable is nowhere to found is never a promising approach.

 

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